Nice Try - Brazilian Central Bank, No Dice!!

As we had expected, the Brazilian Central Bank (BCB) did hike its policy rate last week to 9.50%, a 75 basis hike rather than the market expectation of 50 basis points. I expect inflation to moderate in the coming months and inflation expectations to hover around the 4.5% target. Political considerations will also continue to play a part in future rate hikes. I believe that we will see acceleration of the rate hikes as we see stronger evidence of demand driven inflation.
All of the BCB board members agreed that:
  1. idle capacity utilization is almost vanished on the back of a strong domestic demand, which in turn was aided by powerful fiscal and lending stimuli,
  2. the BCB's macro economic framework points to its own inflation forecast above the target,
  3. the markets inflation expectations are clearly above the target as well,
  4. the benefits of a strong BRL on inflation are decreasing and also the BRL could depreciate if commodity prices fall and/or due to the normalization of international liquidity conditions.
Therefore, there it was imminent that the tightening cycle would begin now. However, the reservations of the 5 board members to start the tightening cycle in March caused me to believe that a 75 basis rate hike would have been the most likely outcome, even though the market expected 50 basis points.
What was fascinating was to see the Central Bank make an announcement last week about selling Brazilian Reals in the open market. The only logical reason for this would be to weaken the Real, since the rate hike would make the Real stronger.

Thank God, we traders saw through this ploy. The jawboning by the BCB did not have any effect on the Real. And once the rates were announced, the value of the Real started soaring. And the great news is that this is only the beginning of the tightening and only the beginning of the next leg up on the Real.
In conclusion: I continue to expect five more policy rate increments of 50bps towards a Selic rate of 12.00% before this stops.

Ashish Advani
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